Professional Documents
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Valuation
page 2
Introduction
page 3
4 Standard Valuation Models
T
F1 F2 FT
V
I
r I t Ft
0
rI r I2 r IT t 1
Here:
rI : One plus the required return on the investment
Ft : Flow variable
T : Last period where the investment provides pay-offs
V : Price
I
page 4
4 Standard Valuation Models
Terminal value: Valuation of a going concern
Ft F FT 1
V0I TVT
t 1
1 r t r r 1
page 5
4 Standard Valuation Models
page 6
4 Standard Valuation Models
The required return (in efficient markets): Capital Asset Pricing Model (CAPM)
r r r r
E F M F r F = Risk free return: Long term government bond
r M r F = Market risk premium: Expected return on the
market portfolio minus risk-free rate
COV r E , r M / M
= Beta: Covariance of asset and market returns,
divided by the variance of the market (m):
Sensitivity of asset return to market returns
Problems with CAPM: Estimates of the cost of capital are made from market
prices and assume that the market is efficient
Normally distributed stock returns are assumed
The market risk premium is a big guess
Betas are estimated with error
Definition of the market portfolio
page 7
idiosyncratic risk--> unsystematic risks
the risk which cannor be diversified
The required return (in efficient markets): Firm weighted average cost of capital
E D V0D
V V
r F rE r D 1 s
0 0 : leverage at market value
F F V0E
V 0 V 0
S : Tax rate
Firm cost of capital: Risk of operations (equals equity cost of unlevered firm)
page 8
1 In this course, we explicitly forecast tax-shield reformulating the income statement
4 Standard Valuation Models
Cus- OR C F Debt
tomers holders
Net
Net
oper-
financial
ating
assets
assets
(NFA)
(NOA)
Suppli- OE I d Share-
ers holder
page 9
4 Standard Valuation Models
The dividend discount model (DDM): The basic model
page 10
treasurer rule.
dividends are not necessarily ties to value creation. companies indulge in dividend smoothing
Advantages:
Easy concept: Dividends are what shareholders get
Predictability: Dividends are usually fairly stable in the short run
Disadvantages
Forecast horizon: Requires long forecast horizon. Short term forecasts are
not informative as firms can adjust, create, or avoid dividends (i.e. use the
NFO/NFA buffer)1
Dividend irrelevance: Dividends are value distributions, not value creation.
Increase in shareholders private wealth is offset by change in share price
Dividend conundrum: Though equity value is determined by future
dividends, forecasting dividends does not give an indication of value
1 https://www.nzz.ch/finanzen/dividende-der-cs-eine-ausschuettung-mit-fragezeichen-ld.145590 page 11
4 Standard Valuation Models
Cus- OR C F Debt
tomers holders
Net
Net
oper-
financial
ating
assets
assets
(NFA)
(NOA)
Suppli- OE I d Share-
ers holder
page 12
4 Standard Valuation Models
page 13
4 Standard Valuation Models
C1 I1 C2 I 2 C3 I 3 CT I T TVT
V0E ... V0D
rF r F2 r F3 r FT r FT
page 14
4 Standard Valuation Models
Advantages
Easy and familiar concept: Cash flows are real. They are not
affected by accounting rules
Disadvantages
DCF does not take advantage of accruals: Matching and the focus
on value generation concept
Investment: Increase is treated as a loss and cutting back
investment can increase free cash flow (i.e., free cash flow is
partly a liquidation concept)
Forecast: Analysts forecast earnings, not free cash flow